Working Paper: NBER ID: w10359
Authors: Charles F. Manski
Abstract: Participants in prediction markets such as the Iowa Electronic Markets trade all-or-nothing contracts that pay a dollar if and only if specified future events occur. Researchers engaged in empirical study of prediction markets have argued broadly that equilibrium prices of the contracts traded are market probabilities' that the specified events will occur. This paper shows that if traders are risk-neutral price takers with heterogenous beliefs, the price of a contract in a prediction market reveals nothing about the dispersion of traders' beliefs and partially identifies the central tendency of beliefs. Most persons have beliefs higher than price when price is above 0.5, and most have beliefs lower than price when price is below 0.5. The mean belief of traders lies in an interval whose midpoint is the equilibrium price. These findings persist even if traders use price data to revise their beliefs in plausible ways.
Keywords: No keywords provided
JEL Codes: D84; G10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Prediction market prices (G13) | Traders' beliefs (D84) |
| Traders are risk-neutral and have heterogeneous beliefs (D80) | Price of a contract does not provide information about dispersion of beliefs (D89) |
| Price of a contract above 0.5 (G13) | Most traders have beliefs higher than the price (G13) |
| Price of a contract below 0.5 (G13) | Most traders have beliefs lower than the price (D46) |
| Equilibrium price (D41) | Midpoint of beliefs interval (C46) |
| Equilibrium price (D41) | Mean belief of traders lies within a specific range (D80) |